The modern economy is built not only on hard work and technological progress, but on itself. Unfortunately, the economy's amazing ability to create a lot from a little goes alongside a terrifying capacity to self-destruct from the smallest catalyst. These capacities can be illustrated by the three different "multipliers" in economics. And thinking about these multipliers is the key to understanding a paradox of the current recession: some of the countries that are least developed are having the least difficult time weathering the crisis.

The money multiplier illustrates how cash and other liabilities of the
Federal Reserve get expanded through all commercial banking activities
to become a much larger amount of bank deposits. The money multiplier
is higher when banks lend more of their reserves, and when firms and
individuals deposit more of their money in financial institutions.

The employment multiplier describes the additional jobs or welfare
generated from an important industry, often in the export sector. For
example, if a manufacturing firm comes to town, it will require
lawyers, doctors, storekeepers, and barbers, not to mention suppliers.

Finally, the fiscal multiplier predicts the net impact of a
deficit-financed government stimulus effected through additional
government spending or tax cuts. The fiscal multiplier is higher when
government expenditures end up in firms' or individuals' pockets, and
when they in turn spend a large percentage of that on goods and
services produced in the economy.

All three of these multipliers sound super. Who wouldn't want to
magically create money, or jobs, or income? Well, the downside is that
when the money multiplier is decreased, or when the initial employment
or fiscal stimulus is negative rather than positive, a lot of wealth or
jobs can be lost.

In this crisis we have seen a lot of "unwinding": of wealth, and of
jobs, particularly in export-led economies. The simple tool of the
multiplier illustrates this. In response to the credit crisis, banks
stopped lending, hedge funds de-levered, firms hoarded cash, and
individuals pulled their money out of bank accounts and money market
funds. So even as the Federal Reserve attempted to inject liquidity
into the U.S. banking system, the fact was that the money multiplier
had dramatically shrunk. With the supply of credit diminished, debts
became harder to service, and asset prices fell. As a result, a whole
lot of wealth was quickly erased from the economy.

Meanwhile, with reduced demand from the United States and Europe, the
export-led economies of East Asia got slammed: in the last quarter of
2008, according to The Economist, Japan's GDP fell at an annualized
rate of 10%, Singapore's at 17%, and South Korea's at 21%. The
employment multiplier has magnified the economic impact of these
initial lost export jobs, leading to a much larger fall in global
demand.

With lending down, and demand down, we are left with the government to
fill in the gap, to try to wind back up the economy through the fiscal
multiplier. Unfortunately, we don't know just how big that multiplier
is, because it is different for every situation. Only time (and a lot
of statistical analysis) will tell.

But in those parts of the world that are less economically
sophisticated, the crisis is creating fewer disruptions. In Sub-Saharan
Africa, the IMF is still forecasting economic growth of 3.5% for 2009.
That's faster than everywhere outside China, India, and the Middle
East.

Why might that be? For one, the money multiplier in sub-Saharan Africa
is already quite low, and therefore cannot fall much further. There is
very little lending there relative to developed countries, and even
less leverage. On a recent trip to a less-developed country in Africa,
I spoke to major businessmen who were only able to get loans equal to 5
or 10 percent of their net worth. These firms were largely
self-financing, and invested out of retained earnings. In addition,
African economies are not a sizeable part of the global supply chain --
except in commodities, which, admittedly, have taken a beating. Thus,
the net effect on lost export jobs will be limited. The employment
multiplier, however high, is being multiplied by a very small number of
export jobs.

Strangely, where the least-developed economies are most vulnerable is
where the rest of the world is trying to ramp up: through the fiscal
multiplier. Many poor countries depend on foreign aid for a large
fraction of their government spending; aid regularly makes up 10-30
percent of their GDP. So if the budgetary crunch in rich countries
results in reduced foreign aid, poor countries would experience the
equivalent of a fiscal contraction, with their GDP falling by the lost
aid times the fiscal multiplier.

As the world has grown more integrated and financially sophisticated,
it has also been multiplied, getting more wound up in itself. In an
ironic twist, the countries that have failed to gain from globalization
also look to suffer the least from this particular recession, which is
one characterized by wholesale unwinding. That is, of course, unless
the fiscal stimuli in the integrated world come at the expense of its
regular cash injections abroad.

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